nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2017‒09‒24
twenty-one papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. International Real Business Cycle Models with Incomplete Information By Guo, Zi-Yi
  2. Model uncertainty in macroeconomics: On the implications of financial frictions By Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
  3. Information heterogeneity, housing dynamics and the business cycle By Guo, Zi-Yi
  4. The Rise of Non-Regulated Financial Intermediaries in the Housing Sector and its Macroeconomic Implications By Hélène Desgagnés
  5. Complementarity between Merit Goods and Private Consumption: Evidence from estimated DSGE model for Japan By Go Kotera; Saisuke Sakai
  6. Default Risk, Sectoral Reallocation and Persistent Recessions By Arellano, Cristina; Bai, Yan; Mihalache, Gabriel
  7. Growth and Bubbles: The Interplay between Productive Investment and the Cost of Rearing Children By Xavier Raurich; Thomas Seegmuller
  8. A Tale of Two Countries: A Story of the French and US Polarization By Albertini, Julien; Hairault, Jean-Olivier; Langot, François; Sopraseuth, Thepthida
  9. Reforming housing rental market in a life-cycle model By Michal Rubaszek
  10. Credit crunches from occasionally binding bank borrowing constraints By Holden, Tom D.; Levine, Paul; Swarbrick, Jonathan M.
  11. A Model of Secular Stagnation: Theory and Quantitative Evaluation By Eggertsson, Gauti B.; Mehrotra, Neil; Robbins, Jacob A.
  12. Estimation bayésienne d'un modèle DSGE pour une petite économie ouverte : Cas de la RD Congo By UMBA, Gilles Bertrand
  13. An economic model of metapopulation dynamics By Stefano BOSI; David DESMARCHELIER
  14. Aggregate Fluctuations and the Role of Trade Credit By Lin Shao
  15. Adjustment Costs and Factor Demand: New Evidence From Firms’ Real Estate By A. Bergeaud; S.Ray
  16. Goods and Factor Market Integration: A Quantitative Assessment of the EU Enlargement By Lorenzo Caliendo; Fernando Parro; Luca David Opromolla; Alessandro Sforza
  17. Do Misperceptions about Demand Matter? Theory and Evidence By Kenza Benhima; Céline Poilly
  18. Where Modern Macroeconomics Went Wrong By Joseph E. Stiglitz
  19. Liquidity, Monetary Policy and Unemployment: A New Monetarist Approach By Mei Dong; Sylvia Xiaolin Xiao
  20. Optimal Population Growth as an Endogenous Discounting Problem: The Ramsey Case By Raouf Boucekkine; Blanca Martínez; José Ramón Ruiz-Tamarit
  21. Global Banking and the Conduct of Macroprudential Policy in a Monetary Union By Poutineau, Jean-Christophe; Vermandel, Gauthier

  1. By: Guo, Zi-Yi
    Abstract: Standard international real business cycle (IRBC) models formulated by Backus, Kehoe, and Kydland (BKK, 1992) have been considered a natural starting point to assess the quantitative implications of dynamic stochastic general equilibrium (DSGE) models in an open economy environment. Since the standard IRBC model under assumptions of flexible prices and perfect competition cannot replicate all the observed characteristics of international business cycles, a number of extended models with more realistic features have been developed in the past two decades. We introduce a noisy information structure into an otherwise standard international real business cycle model with two countries. When domestic firms observe current foreign technology with some noise, predictions of the model on international correlation can be very different from those of a standard perfect information model. We show that the model can explain: (i) positive output correlation both in complete and incomplete market models; (ii) consumption correlation smaller than output correlation with an introduction of information constrained consumers; and (iii) observation of both positive and negative productivity-hours correlation in two countries.
    Date: 2017
  2. By: Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
    Abstract: For some time now, structural macroeconomic models used at central banks have been predominantly New Keynesian DSGE models featuring nominal rigidities and forwardlooking decision-making. While these features are widely deemed crucial for policy evaluation exercises, most central banks have added more detailed characterizations of the financial sector to these models following the Great Recession in order to improve their fit to the data and their forecasting performance. We employ a comparative approach to investigate the characteristics of this new generation of New Keynesian DSGE models and document an elevated degree of model uncertainty relative to earlier model generations. Policy transmission is highly heterogeneous across types of financial frictions and monetary policy causes larger effects, on average. The New Keynesian DSGE models we analyze suggest that a simple policy rule robust to model uncertainty involves a weaker response to inflation and the output gap in the presence of financial frictions as compared to earlier generations of such models. Leaning-against-the-wind policies in models of this class estimated for the Euro Area do not lead to substantial gains. With regard to forecasting performance, the inclusion of financial frictions can generate improvements, if conditioned on appropriate data. Looking forward, we argue that model-averaging and embracing alternative modelling paradigms is likely to yield a more robust framework for the conduct of monetary policy.
    Keywords: model uncertainty,model comparison,New Keynesian DSGE,financial frictions,monetary policy transmission,fiscal policy transmission,macroprudential policy transmission,robust monetary policy,forecasting
    Date: 2017
  3. By: Guo, Zi-Yi
    Abstract: Empirical evidence shows that house prices are highly volatile and closely correlated with the business cycle, and the fact is at odds with the evidence that rental prices are relatively stable and almost uncorrelated with the business cycle. To explain the fact, we introduce information heterogeneity into a standard dynamic stochastic general equilibrium (DSGE) model with financial frictions. Agents are endowed with heterogeneous shocks, and rationally extract information from market activities. Since agents are confused by changes in average private signals about future fundamentals, the model generates an amplified effect of technology shocks on house prices, which accounts for the disconnect between house prices and the discounted sum of future rents. In addition, the model provides insights for the lead-lag relationship between residential and nonresidential investment over the business cycle. The solution method developed in this paper can be applied in other DSGE models with heterogeneous information.
    Date: 2017
  4. By: Hélène Desgagnés
    Abstract: I examine the impact of non-regulated lenders in the mortgage market using a dynamic stochastic general equilibrium (DSGE) model. My model features two types of financial intermediaries that differ in three ways: (i) only regulated intermediaries face a capital requirement, (ii) non-regulated intermediaries finance themselves by selling securities and cannot accept deposits, and (iii) non-regulated intermediaries face a more elastic demand. This last assumption is based on empirical evidence for Canada revealing that non-regulated intermediaries issue loans at a lower interest rate. My results suggest that the non-regulated sector contributes to stabilize the economy by providing an alternative source of capital when the regulated sector in unable to fulfill the demand for credit. As a result, an economy with a large non-regulated sector experiences a smaller downturn after an adverse financial shock.
    Keywords: Business fluctuations and cycles, Economic models, Financial system regulation and policies, Housing
    JEL: E32 E44 E47 E60 G21 G23 G28
    Date: 2017
  5. By: Go Kotera (Policy Research Institute, Ministry of Finance Japan); Saisuke Sakai (Policy Research Institute, Ministry of Finance Japan)
    Abstract: This study constructs a dynamic stochastic general equilibrium model and empirically investigates the effects of fiscal policy in Japan with focus on the functional difference in government expenditures. Specifically, we divide government consumption into merit and public goods and examine their external effect on private consumption. Our estimation using Japanese quarterly data from 1981:Q1 to 2012:Q4 indicates that merit goods are complements for private consumption, while public goods are substitutes, and consequently, the expenditure on merit goods has greater positive effects on the economy than public goods. Furthermore, we show that Japanese government expenditures are highly persistent and their response to the GDP gap and national debt accumulation is limited. These findings suggest that the complementarity between private consumption and merit goods is a major factor causing a fiscal crowding-in effect on private consumption.
    Keywords: Edgeworth complementarity; Fiscal policy; DSGE modeling; Bayesian estimation
    JEL: C11 E32 E62
    Date: 2017–09
  6. By: Arellano, Cristina (Federal Reserve Bank of Minneapolis); Bai, Yan (University of Rochester); Mihalache, Gabriel (Stony Brook University)
    Abstract: Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital inflows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a reflection of the scarcity of traded goods. We find that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.
    Keywords: European debt crisis; Traded and nontraded production; Real exchange rate; Capital accumulation; Sovereign default with production economy
    JEL: E30 F30
    Date: 2017–09–13
  7. By: Xavier Raurich (Departament de Teoria Econòmica and CREB, Universitat de Barcelona); Thomas Seegmuller (Aix-Marseille Univ. (Aix-Marseille School of Economics), CNRS, EHESS and Centrale Marseille)
    Abstract: As it is documented, investment of households in human capital is negatively related to the number of children individuals will have and requires some loans to be financed. We show that this negative relationship contributes to explain episodes of bubbles that are associated to higher growth rates. This conclusion is obtained in an overlapping generations model where agents choose to invest in a productive asset, that can be interpreted as human capital, and decide their number of children. A bubble allows to smooth consumption and expenses over the life-cycle, and can therefore be used to finance either productive investment or the cost of rearing children. The time cost of rearing children plays a key role in the analysis. If the time cost per child is sufficiently large, households have only a small number of children. The bubble then has a crowding-in effect because it is used to finance productive investment. On the contrary, if the time cost per child is low enough, households have a large number of children. Then, the bubble is mainly used to finance the total cost of rearing children and has a crowding-out effect on investment. Therefore, the new mechanism we highlight shows that a bubble enhances growth only if the economy is characterized by a high rearing time cost per child.
    Keywords: bubble, sustained growth, fertility
    JEL: E44 G12 J11
    Date: 2017
  8. By: Albertini, Julien (University of Lyon 2); Hairault, Jean-Olivier (University of Paris 1 Panthéon-Sorbonne); Langot, François (University of Le Mans); Sopraseuth, Thepthida (University of Cergy-Pontoise)
    Abstract: This study investigates job polarization in the United States and in France. In the data, the dynamics of employment shares for abstract, routine, and manual jobs appear very similar in the two countries. This similarity actually hides major differences in the dynamics of employment levels by tasks. In particular, the routine employment level fell significantly in France until the mid-1990s, and then rebounded until 2007. The evolution of US routine employment went in opposite directions to that of the French economy. We then develop a multi-sectorial search and matching model with endogenous occupational choice to disentangle the respective contributions of task-biased technological change (TBTC), labor market institutions (LMI), and rising educational attainment to job polarization. For the US economy, we find that TBTC and the rising supply of skilled labor are the main drivers of polarization in a context of growing employment levels. In France, in contrast, polarization is driven mainly by LMI changes. This led to a sharp drop in routine employment in a context of declining aggregate employment until the mid-1990s, which then reversed when the impact of the minimum wage was alleviated by a subsidy policy targeted at low wage earners. Next, we quantify the welfare consequences of job polarization. Abstract and manual workers are the main winners of job polarization in both countries. Welfare gains and losses are more dispersed in the routine group. The most productive French routine workers would have been worse off without LMI changes. In contrast, displaced low-ability, routine French workers would have preferred a more flexible labor market to improve their employment prospects in their occupational change. All US routine workers suffered as a result of the drop in LMI generosity.
    Keywords: search and matching, job polarization, labor market institutions
    JEL: E24 J62 J64 O33
    Date: 2017–09
  9. By: Michal Rubaszek
    Abstract: Housing rental market share in most countries around the world is low. We explore the reasons behind this underdevelopment with a survey conducted among a representative group of 1005 Poles. It turns out that strong tenure preferences of households toward owning can be attributed to both economic and psychological factors. Building on these findings, we develop a life-cycle model and evaluate the effect of the following reforms aimed at improving the functioning of the rental market: (i) changing the quality of rental services, (ii) reducing the risk of investment in rental housing and (iii) removing fiscal incentives for owning. The results indicate that the reforms, if introduced simultaneously, significantly increase the rental market share.
    Keywords: Housing rental market, survey data, life-cycle model, heterogenous agent model.
    JEL: D91 E21 R21
    Date: 2017–09
  10. By: Holden, Tom D.; Levine, Paul; Swarbrick, Jonathan M.
    Abstract: We present a model in which banks and other financial intermediaries face both occasionally binding borrowing constraints, and costs of equity issuance. Near the steady state, these intermediaries can raise equity finance at no cost through retained earnings. However, even moderately large shocks cause their borrowing constraints to bind, leading to contractions in credit offered to firms, and requiring the intermediaries to raise further funds by paying the cost to issue equity. This leads to the occasional sharp increases in interest spreads and the counter-cyclical, positively skewed equity issuance that are characteristic of the credit crunches observed in the data.
    Keywords: Occasionally binding constraints,Credit crunches,Financial crises,Spreads,Dividends,Equity,Banking
    JEL: E22 E32 E51 G2
    Date: 2017
  11. By: Eggertsson, Gauti B. (Brown University); Mehrotra, Neil (Federal Reserve Bank of Minneapolis); Robbins, Jacob A. (Brown University)
    Abstract: This paper formalizes and quantifies the secular stagnation hypothesis, defined as a persistently low or negative natural rate of interest leading to a chronically binding zero lower bound (ZLB). Output-inflation dynamics and policy prescriptions are fundamentally different from those in the standard New Keynesian framework. Using a 56-period quantitative life cycle model, a standard calibration to US data delivers a natural rate ranging from -1.5% to -2%, implying an elevated risk of ZLB episodes for the foreseeable future. We decompose the contribution of demographic and technological factors to the decline in interest rates since 1970 and quantify changes required to restore higher rates.
    Keywords: Secular stagnation; Monetary policy; Zero lower bound
    Date: 2017–09–05
  12. By: UMBA, Gilles Bertrand
    Abstract: The aim of this work was to estimate a DSGE-SOE model for the DR Congo by referring to the Bayesian techniques for the quarterly data from 2002q1 to 2016q4 in order to analyze the relations between the main macroeconomic variables and to simulate the " impact of some major shocks on their evolution. The results of model estimation were generally satisfactory, especially with respect to the convergence tests of Brooks and Gelman (1998). The results of the analysis of historical decomposition have revealed the influence of exchange rate and output shocks on internal and external productivity shocks as the main determinants of the policy rate and interest rate movements. domestic inflation. An analysis of the historical decomposition of the rate of exchange rate depreciation has indicated the notorious influence of exchange rate and monetary policy shocks in the explanation of exchange rate depreciation during the last three quarters of the year 2016.
    Keywords: Open economy, Dynamic stochastic general equilibrium models, Bayesian techniques, New Keynesian models
    JEL: C32 C51 E52 F41
    Date: 2017–09–09
  13. By: Stefano BOSI; David DESMARCHELIER
    Abstract: In this paper, we aim to model the impact of human activities on the wildlife habitat in a general equilibrium framework by embedding the Levins model (1969) of metapopulation dynamics into a Ramsey model (1928) with a pollution externality. In the long run, as in Levins (1969), two steady states coexist: a zero one with mass extinction and anotherone with positive wildlife when the migration rate of the metapopulation exceeds the rate of extinction. A green tax always increases the wildlife and lowers the consumption demand. It is welfare-improving if and only if agents overweight the wildlife. In the short run, we show that a sufficiently negative effect of wildlife habitat on consumption demand can lead to the emergence of a limit cycle near the positive steady state through a Hopf bifurcation. We show also that the negative pollution effect on wildlife habitat works as a destabilizing force in the economy by promoting limit cycles.
    Keywords: metapopulation dynamics, pollution, Ramsey model, Hopf bifurcation.
    JEL: C61 E32 O44
    Date: 2017
  14. By: Lin Shao
    Abstract: In an economy where production takes place in multiple stages and is subject to financial frictions, how firms finance intermediate inputs matters for aggregate outcomes. This paper focuses on trade credit—the lending and borrowing of input goods between firms—and quantifies its aggregate impacts during the Great Recession. Motivated by empirical evidence, our model shows how trade credit alleviates financial frictions through a process of credit redistribution and creation, thus leading to a higher output level in the steady state. However, in the face of financial market distress, suppliers cut back trade credit lending, further tightening their customers’ borrowing constraint. The decline in economic activities following financial shocks is in turn amplified by disruptions in trade credit. Our model simulation suggests that the drop in trade credit during the Great Recession can account for almost one-fourth of the observed decline in output.
    Keywords: Business fluctuations and cycles, Credit and credit aggregates, Firm dynamics
    JEL: E32 E44 E51
    Date: 2017
  15. By: A. Bergeaud; S.Ray
    Abstract: Adjustment costs impair the optimal allocation of production factor across firms. In this paper, we use the cost associated with corporate relocation to explore the effect of the adjustment costs of the premises size on factor demand. We rely on the tax on realized capital gains on real estate asset, which entails varying real estate adjustment costs across firms, to empirically study the effect of these frictions on firms' behaviour. We develop a general equilibrium model, with heterogeneous firms, that sheds light on the implication of the level of the fixed costs associated with the adjustment of real estate on the change in firms' labor demand following productivity shocks. This model predicts that employment growth of firms facing positive productivity shocks shrinks with the level of the frictions. Confronting these results using French firm-level data over the period 1994-2013, we find that higher adjustment costs constrain relocation and reduce job creation of the most dynamic firms. The highlighted frictions have noticeable macroeconomic effects.
    Keywords: Corporate real estate; Firms' relocation; Adjustment costs; Misallocation of resources.
    JEL: D21 D22 H25 J21 O52 R30
    Date: 2017
  16. By: Lorenzo Caliendo (Yale University); Fernando Parro (Johns Hopkins University); Luca David Opromolla (Banco de Portugal); Alessandro Sforza (London School of Economics)
    Abstract: The economic e?ects from labor market integration are crucially a?ected by the extent to which countries are open to trade. In this paper we build a multi-country dynamic general equi¬librium model with trade in goods and labor mobility across countries to study and quantify the economic e?ects of trade and labor market integration. In our model trade is costly and features households of di?erent skills and nationalities facing costly forward-looking relocation decisions. We use the EU Labour Force Survey to construct migration ?ows by skill and na¬tionality across 17 countries for the period 2002-2007. We then exploit the timing variation of the 2004 EU enlargement to estimate the elasticity of migration ?ows to labor mobility costs, and to identify the change in labor mobility costs associated to the actual change in policy. We apply our model and use these estimates, as well as the observed changes in tari?s, to quantify the e?ects from the EU enlargement. We ?nd that new member state countries are the largest winners from the EU enlargement, and in particular unskilled labor. We ?nd smaller welfare gains for EU-15 countries. However, in the absence of changes to trade policy, the EU-15 would have been worse o? after the enlargement. We study even further the interaction e?ects between trade and migration policies and the role of di?erent mechanisms in shaping our results. Our results highlight the importance of trade for the quanti?cation of the welfare and migration e?ects from labor market integration
    Keywords: International trade, Factor mobility, Market integration, EU enlargement, Welfare
    JEL: F16 F22 F13 J61 R13 E24
    Date: 2017–09
  17. By: Kenza Benhima (University of Lausanne, HEC-DEEP and CEPR); Céline Poilly (Aix-Marseille Univ. (Aix-Marseille School of Economics), CNRS, EHESS and Centrale Marseille)
    Abstract: We assess theoretically and empirically the consequences of demand misperceptions. In a New Keynesian model with dispersed information, agents receive noisy signals about both supply and demand. Firms and consumers have an asymmetric access to information, so aggregate misperceptions of demand by the supply side can drive economic fluctuations. The model’s predictions are used to identify empirically fundamental and noise shocks on supply and demand. We exploit survey nowcast errors on both GDP growth and inflation, fundamental and noise shocks affecting the errors with opposite signs. We show that demand-related noise shocks have a negative effect on output and contribute substantially to business cycles. Additionally, monetary policy plays a key role in the transmission of demand noise.
    Keywords: Business cycles, information frictions, noise shocks, SVARs with sign restrictions
    JEL: E32 D82 C32 E31
    Date: 2017–05
  18. By: Joseph E. Stiglitz
    Abstract: This paper provides a critique of the DSGE models that have come to dominate macroeconomics during the past quarter-century. It argues that at the heart of the failure were the wrong microfoundations, which failed to incorporate key aspects of economic behaviour, e.g. incorporating insights from information economics and behavioural economics. Inadequate modelling of the financial sector meant they were ill-suited for predicting or responding to a financial crisis; and a reliance on representative agent models meant they were ill-suited for analysing either the role of distribution in fluctuations and crises or the consequences of fluctuations on inequality. The paper proposes alternative benchmark models that may be more useful both in understanding deep downturns and responding to them.
    JEL: A1 A2 E0 E1
    Date: 2017–09
  19. By: Mei Dong (Department of Economics, University of Melbourne); Sylvia Xiaolin Xiao (School of Economics, Auckland University of Technology)
    Abstract: We discover a consumption channel of monetary policy in a model with money and government bonds. When the central bank withdraws government bonds (short-term or long-term) through open market operations, it lowers re- turns on bonds. The lower return has a direct negative impact on consumption by households that hold bonds, and an indirect negative impact on consumption by households that hold money. As a result, fi rms earn less pro fits from production, which leads to higher unemployment. The existence of such a consumption channel can help us understand the e¤ects of unconventional monetary policy.
    Keywords: interest rate, monetary policy, consumption, unemployment
    Date: 2017–07
  20. By: Raouf Boucekkine (Aix-Marseille Univ. (Aix-Marseille School of Economics), CNRS, EHESS and Centrale Marseille); Blanca Martínez (Universidad Complutense de Madrid); José Ramón Ruiz-Tamarit (Universitat de Valencia, Spain, and IRES Department of Economics, Université Catholique de Louvain, Belgium)
    Abstract: This paper revisits the optimal population size problem in a continuous time Ramsey setting with costly child rearing and both intergenerational and intertemporal altruism. The social welfare functions considered range from the Millian to the Benthamite. When population growth is endogenized, the associated optimal control problem involves an endogenous effective discount rate depending on past and current population growth rates, which makes preferences intertemporally dependent. We tackle this problem by using an appropriate maximum principle. Then we study the stationary solutions (balanced growth paths) and show the existence of two admissible solutions except in the Millian case. We prove that only one is optimal. Comparative statics and transitional dynamics are numerically derived in the general case.
    Keywords: Optimal population size, population ethics, optimal growth, endogenous discounting, optimal demographic transitions
    JEL: C61 C62 J1 O41
    Date: 2017–08
  21. By: Poutineau, Jean-Christophe; Vermandel, Gauthier
    Abstract: This paper questions the role of cross-border lending in the definition of national macroprudential policies in the European Monetary Union. We build and estimate a two-country DSGE model with corporate and interbank cross-border loans, Core-Periphery diverging financial cycles and a national implementation of coordinated macroprudential measures based on Countercyclical Capital Buffers. We get three main results. First, targeting a national credit-to-GDP ratio should be favored to federal averages as this rule induces better stabilizing performances in front of important divergences in credit cycles between core and peripheral countries. Second, policies reacting to the evolution of national credit supply should be favored as the transmission channel of macroprudential policy directly impacts the marginal cost of loan production and, by so, financial intermediaries. Third, the interest of lifting up macroprudential policymaking to the supra-national level remains questionable for admissible value of international lending between Eurozone countries. Indeed, national capital buffers reacting to the union-wide loan-to-GDP ratio only lead to the same stabilization results than the one obtained under the national reaction if cross-border lending reaches 45%. However, even if cross-border linkages are high enough to justify the implementation of a federal adjusted solution, the reaction to national lending conditions remains remarkably optimal.
    Keywords: Macroprudential Policy; Global Banking; International Business Cycles; Euro Area
    JEL: E58 F34 F4 F42
    Date: 2016–11–01

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